A Banker in Germany Says Trouble Is Not Over

Tuesday

Nov 27, 2007 at 5:22 AM

Nearly five months after the mortgage mess spilled into Europe, the head of Commerzbank said the full extent of the damage was still unclear.

FRANKFURT, Nov. 26 — Klaus-Peter Müller spent the better part of a decade working in the New York branch of Commerzbank, the German bank he now heads as chief executive. His daughter was born in Manhattan, and he has kept close ties to the United States.

But Mr. Müller is unsparing in his criticism of American mortgage-market excess, which has mutated into a trans-Atlantic financial crisis, nearly ruined two German banks and, he predicts, will wreak more havoc in the investment portfolios of other European banks.

Nearly five months after the mortgage mess spilled into Europe, Mr. Müller, 63, and president of the German banking association, said the full extent of the damage was still unclear. While he does not foresee a new land mine in Germany, he expects more bad news from banks that have not yet acknowledged owning a slice of American-style risk.

Referring to television commercials in the United States that promised loans with no proof of income, Mr. Müller said, “I do not believe you should lend money to people whose income you have not properly checked.”

Mr. Müller is similarly unsparing about German banks, including his own, which invested in securities backed by subprime mortgages.

“You need to be straight with yourself,” he said Monday in an interview in his office at the top of the Commerzbank tower here. “Nobody was forced, to the best of my knowledge, to buy U.S. subprime products.”

Bankers, Mr. Müller said, did not adequately understand these investments and relied too heavily on high-grade credit ratings from agencies that helped put together the products, then rated them. This ignorance of the risks extended to the top echelons of the banks.

“Did I know in March of ‘04 that there was a U.S. subprime market” that was going to face serious problems in the next few years? he asked. “No, I didn’t have the slightest idea. I was a happy man then.”

Mr. Müller is one of a small circle of European bankers who are now speaking out about the subprime fiasco.

He confesses to frustration: Although European banks, as a whole, do not appear to have been as hard hit as American ones; the assumption among some in the United States is that Europeans ended up holding many of these investments. This was reinforced by the fact that the first banks to get into trouble were two midsize German banks: IKB Deutsche Industriebank and Sachsen LB.

Mr. Müller contends it is primarily an American malady. “Some people in the U.S. market thought this was a European story,” he said. “But all the major numbers we’ve seen are U.S.-denominated.”

Commerzbank has not been invited to take part in the fund of at least $75 billion that is being cobbled together by leading American banks to stabilize the credit markets, Mr. Müller said. And given his bank’s relatively modest role in the credit crisis, he sees little reason that it should.

Late in July, Commerzbank said it had 1.2 billion euros ($1.8 billion) of exposure to subprime markets. It wrote down the value of its portfolio by 337 million euros ($501 million). The losses were incurred by its New York office and the New York office of its real estate arm, Eurohypo.

Commerzbank still has a team of 30 to 40 people searching through its books. It is painstaking work, involving tricky calculations as to the likelihood that mortgages will default. The process will be finished by the end of the year, allowing the bank to make a full accounting in its annual report.

“I’m personally waiting for the numbers, as of the year-end,” Mr. Müller said. “By then, everyone will put their cards on the table, so that you know who is positioned in what situation.”

Indeed, Mr. Müller said the trickle of information from the banks had compounded the recent jitters in the market. Commerzbank reported its exposure early, he said, in part to prod other banks to disclose their positions.

But few followed suit, apparently believing that they could ride it out. “One of the miseries of the whole story is that we sliced the news on this topic like a salami sausage,” he said. “The public kept on receiving bad news, which was not a very professional way of handling it.”

To Mr. Müller, however, post-mortems are less important than drawing lessons for the next time.

The main lesson, he said, is that banks should not substitute the judgment of the ratings agencies for that of their own bankers when it comes to assessing the risk of an investment vehicle.

Mr. Müller does not yearn for a European ratings agency to counter the influence of Standard & Poor’s and Moody’s Investors Service. But he said the agencies should no longer help banks put together packages of securities, and then rate those investments.

Regulation and supervision is a thornier issue. In California, Mr. Müller argued, mortgage brokers are barely supervised. But as a European, he said he did not feel comfortable calling on the United States Congress to impose regulations on the consumer finance industry.

“These are questions that have to be asked and answered in the United States,” he said.

In Europe, a soon-to-be-adopted banking accord will limit the assets that banks can keep off their balance sheets, he said. Had this been in place earlier, a bank like IKB would not have been able to use off-balance sheet assets so aggressively, storing up problems for later.

Beyond that, banks need to think about what prompted their move into subprime-mortgage investments, he said. In most cases, banks sought out the sparkling returns of these riskier investments because they could not find similar returns in investments at home.

“Why are the Russians not in it? Why are the Spanish not in it?” Mr. Müller asked. “If you have domestic business with spreads higher than U.S. subprime, then why should you do it?”

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